Executive Compensation and RRA '93

Villasana, George A., The CPA Journal

Between 1971 and 1981, average executive compensation grew by 30%. During the 1980s, CEO compensation skyrocketed by 212%. In 1990, Forbes put the average total compensation of top executives at $1.592 million. The Hay Group, a Philadelphia consulting firm specializing in compensation issues, reported that the average 11 salary of American chief executives had grown to an estimated $1.7 million. In 1992, the average CEO of a large U.S. corporation received $3.5 million, a 5o increase from the previous year. Clearly, executive compensation is rising at an unprecedented rate at a time when corporations are regularly announcing layoffs and cost-cutting measures. As a result, political activists have been clamoring for change.

In response to such activities, in 192 the SEC adopted new rules for disclosure of executive compensation in proxy and other statements effective January 1, 1993. The new rules could be viewed as an indirect attempt by the SEC to use expanded disclosure requirements to regulate the compensation of corporate officers. Some opponents also view the FASB's proposed statement on stock options as a means to restrict the use of stock options as a vehicle for executive compensation. The most direct attack has come from Congress.

Although the government refused to directly control private sector compensation through the securities laws, it devised a way to do so via the tax code. Critics clamor that the government should not influence private compensation levels, but the tax code has done just that for many decades. Personal income tax levels have historically fluctuated, depending on the economic theories of the administration in power. In 1920, the top tax rate was 73%. By 1925, the top rate had been reduced to 25%. After the 1929 stock market crash and the advent of the New Deal, the top rate increased to 79% by 1936 and then to 91% in the late 1940s. And in the 1960s it settled at about 70% where it remained stable until 1981. During those decades of high tax rates, the average executive earned considerably more than the average worker. However, his proportionally higher tax rate significantly reduced the disparity. Furthermore, the futility of awarding huge salaries only to see them swallowed up by taxes worked to keep salaries lower.

During the 1980s, the highest nominal tax rate dropped from 70% to 28%, significantly increasing the after-tax disparity between worker and executive income by removing the disincentive (tax obstacle) to granting large compensation packages. In the early 1980s, the average pay of a CEO was $624,996, which was 42 times the pay of the average factory worker. By 1990, the average executive's pay, not including stock options, had increased to $1,214,090 which was 85 times the salary of the average factory worker. Many people believe the rich have gotten richer at the expense of factory workers and other lower level employees.

Prior to the enactment of the RRA '93, a corporation was allowed to deduct the amount of compensation paid to an employee, as long as the compensation was reasonable. The unreasonable portion of compensation is nondeductible. If the recipient is a shareholder of the payor-corporation, the unreasonable portion may be treated as a dividend. Reasonable compensation is defined as an amount that would ordinarily be paid for like services by like businesses under like circumstances. However, RRA '93 attempts to apply clearer limits to executive compensation.

The Senate Finance Committee stated its belief that excessive compensation will be reduced if the deduction for compensation (other than performance-based compensation) paid to the top executives of public corporations is limited to $1 million per year. Therefore, the RRA '93 amended the IRC by adding Sec. 162(m). This amendment is expected to raise $335 million in tax revenue during the period 1994 through 1998.

Effective for tax years beginning after 1993, IRC Sec. …

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